Bilateral Oligopoly
BILATERAL OLIGOPOLY
INTRODUCTION:
Most markets are not made up of many individual consumers and many suppliers (producers). Most markets in an industrial/informational economy are markets for inputs and markets for capital goods, including information communications and technology products and services. These markets have corporations on both the supply and the demand sides of the market. Many of these markets are dominated by large companies that are part of an oligopoly (large percent of sales from a small number of companies) in their own industries. The markets for many inputs are bilateral oligopolies, markets with oligopolistic companies on both sides of the market.
MARKETS FOR CAPITAL EQUIPMENT
Economics textbooks talk about putting inputs together in the most cost-effective way possible to produce some level of output. But if capital goods markets are not perfectly-competitive, there is no indication on how this is done.
Markets for capital goods and many other inputs are structured differently than the consumer products markets that are the usual examples in economics. Capital goods, processed metals like steel and aluminum, chemicals and petrochemicals, packaging material, transportation equipment, business information and communication systems, subassemblies, and other inputs are often produced by large corporations in oligopolistic industries. There are often large economies of scale and scope compared to the size of the market. Or entry of new firms is difficult because of specialized knowledge based on past learning curves, patents, "firm-specific" knowledge (private or proprietary knowledge). Yet, contrary to implications in economics textbooks, companies in these types of industries are very competitive, including fierce price competition. Long-run economic profits - profits above the cost of capital - are surprisingly rare. Outcomes in many of these industries approach the ideal outcomes as if these industries were perfectly competitive.
One of the reasons for price competition and lack of market power is that the other side of the market does not consist of a large number of relatively uninformed consumers. There are corporations on both sides of markets that are part of supply or value-added chains. The buy side of the market is often dominated by large corporations that spend resources to be well-informed about suppliers. They challenge the potential market power of large suppliers because they are large buyers with countervailing market power. There is probably limited long-term economic rents to asymmetric information. Such a market structure is called a bilateral oligopoly.
INTRODUCTION:
Most markets are not made up of many individual consumers and many suppliers (producers). Most markets in an industrial/informational economy are markets for inputs and markets for capital goods, including information communications and technology products and services. These markets have corporations on both the supply and the demand sides of the market. Many of these markets are dominated by large companies that are part of an oligopoly (large percent of sales from a small number of companies) in their own industries. The markets for many inputs are bilateral oligopolies, markets with oligopolistic companies on both sides of the market.
MARKETS FOR CAPITAL EQUIPMENT
Economics textbooks talk about putting inputs together in the most cost-effective way possible to produce some level of output. But if capital goods markets are not perfectly-competitive, there is no indication on how this is done.
Markets for capital goods and many other inputs are structured differently than the consumer products markets that are the usual examples in economics. Capital goods, processed metals like steel and aluminum, chemicals and petrochemicals, packaging material, transportation equipment, business information and communication systems, subassemblies, and other inputs are often produced by large corporations in oligopolistic industries. There are often large economies of scale and scope compared to the size of the market. Or entry of new firms is difficult because of specialized knowledge based on past learning curves, patents, "firm-specific" knowledge (private or proprietary knowledge). Yet, contrary to implications in economics textbooks, companies in these types of industries are very competitive, including fierce price competition. Long-run economic profits - profits above the cost of capital - are surprisingly rare. Outcomes in many of these industries approach the ideal outcomes as if these industries were perfectly competitive.
One of the reasons for price competition and lack of market power is that the other side of the market does not consist of a large number of relatively uninformed consumers. There are corporations on both sides of markets that are part of supply or value-added chains. The buy side of the market is often dominated by large corporations that spend resources to be well-informed about suppliers. They challenge the potential market power of large suppliers because they are large buyers with countervailing market power. There is probably limited long-term economic rents to asymmetric information. Such a market structure is called a bilateral oligopoly.
DEFINITION OF A BILATERAL OLIGOPOLY
All models of market structure assume that the demand side is represented by a large number of buyers. The structure of the market, and the assumed market outcomes, depends on the number of suppliers and how they compete. Suppliers either post one price or exploit their knowledge of buyer categories by using price discrimination.Despite the comments about the key role of consumers in determining economic performance, consumers are fairly passive when the discussion focuses on imperfectly-competitive industries. But many markets are not structured this way; the buyers are not price-taking consumers but large corporations that do not passively accept suppliers’ offered prices. Net prices are actively negotiated. These markets are often bilateral oligopolies.
In a bilateral oligopoly the buyers are often a small number of professional buyers and purchasing agents representing large purchasers. The buyers are assumed to be corporations, although they could be large organizations like buyers cooperatives, central buying offices for many firms, or the national government. Sellers are surrounded by a competitive fringe and worry about potential entrants with new, better technology, particularly large companies from other countries or related industries.
There are now a small number of large corporations on both sides of the market. The same company could be on different sides of two bilateral oligopolistic markets. For example, Boeing Aircraft is a major purchaser of jet engines from the three big engine producers and one of two major suppliers (with Airbus) of large commercial aircraft to a limited number of large airlines.
All models of market structure assume that the demand side is represented by a large number of buyers. The structure of the market, and the assumed market outcomes, depends on the number of suppliers and how they compete. Suppliers either post one price or exploit their knowledge of buyer categories by using price discrimination.
Despite the comments about the key role of consumers in determining economic performance, consumers are fairly passive when the discussion focuses on imperfectly-competitive industries. But many markets are not structured this way; the buyers are not price-taking consumers but large corporations that do not passively accept suppliers’ offered prices. Net prices are actively negotiated. These markets are often bilateral oligopolies.
In a bilateral oligopoly the buyers are often a small number of professional buyers and purchasing agents representing large purchasers. The buyers are assumed to be corporations, although they could be large organizations like buyers cooperatives, central buying offices for many firms, or the national government. Sellers are surrounded by a competitive fringe and worry about potential entrants with new, better technology, particularly large companies from other countries or related industries.
There are now a small number of large corporations on both sides of the market. The same company could be on different sides of two bilateral oligopolistic markets. For example, Boeing Aircraft is a major purchaser of jet engines from the three big engine producers and one of two major suppliers (with Airbus) of large commercial aircraft to a limited number of large airlines.
DESCRIPTION OF A BILATERAL OLIGOPOLY
Many producers sell intermediate goods and capital goods to final producers and assemblers. Final producers often sell to large wholesalers, distributors and retailers. Even small retailers often purchase through franchisors, buying offices or big coop distributors like True Value. In all these situations, it is professional buyers who make the buying decision. Purchasing agents and new product committees are well-informed about their suppliers. Because they represent large customers, they have substantial market power, playing off one supplier against another. They buy in large volume, often for their own private label, and are compensated for negotiating low prices. In the extreme, retailers like Walmart force suppliers to offer prices close to the suppliers' marginal cost, the same prices that would prevail in a perfectly-competitive market.
In many bilateral oligopolistic markets, price is the primary consideration in the purchasing decision. Professional buyers are not swayed by marketing or advertising. Brand names are often unimportant or irrelevant in markets for raw materials, commodities, industrial products, intermediate goods, commodity chemicals, products made to buyer’s specifications, generic products, and private label products. Price at or near marginal cost occurs when competing products are close or perfect substitutes in the eyes of the professional buyers. When buyers view alternative sources of inputs as close substitutes, sellers can not charge a premium price based on perceived superior value. In economic jargon, buyers have price elastic demand.
Corporate buyers have leverage if their company is a relatively big part of the market or if producers have large economies of scale. The downside of scale economies in an industrial economy is large fixed costs and low marginal cost compared to price. One implication of large economies of scale is that producers are forced to run plants at a high percent of capacity to make a profit. Industries with large economies of scale also often have industry overcapacity so that not all companies can run their plants at full capacity. As long as price is above marginal cost, some companies would be willing to expand output to increase profit or reduce loss. For example, auto company purchasing agents negotiate with large suppliers from the steel, aluminum, plastics, and tire industries, all of which periodically have excess capacity.
There are a small number of producers in many markets for raw material, semi-processed goods or industrial products because of large economies of scale. Scale economies create the "through-put problem" for suppliers (see the writings of Alfred D. Chandler).Economies of scale are made possible by large up-front investment in fixed assets. Units of output have low variable cost. But there is low average (unit) cost only if plants are run at high rates of capacity. If producers have high fixed cost relative to variable costs and must operate plants at a high percent of capacity to make an adequate rate of return, or plant closing costs are high, then large buyers might be able to force the contract or negotiated price down close to marginal cost.
Many large manufacturers face large assemblers or retailers as major customers. If products are viewed as homogeneous by buyers, suppliers are chosen primarily on price. Buyers use a number of bidding and contract negotiation procedures to maximize the amount of price competition among potential suppliers.
For some products, like computer hardware and systems, the part of the market where computer companies sell computer systems to large institutions contains aspects of bilateral oligopoly. About 40% of total demand for information technology comes from large companies, about 45% from midsize to small businesses, and only about 15% from individual consumers. Merrill Lynch, like many banks and other large financial companies, spend over $1 billion a year on computers and computer systems. They have tremendous market power - negotiating power - when they decide which suppliers to choose.
Buyers for assemblers and retailers typically face final consumers and competitors in their product markets. So demand in intermediate markets is derived from the buyers' forecasts of final consumer demand. Professional buyers are actually negotiating part of the cost of the final product for the ultimate consumer. They have a big incentive to try for the lowest cost of inputs, which will give their company a competitive advantage in the output market.Price competition in the final goods or retail market keeps profit margins down.
Unlike other imperfectly competitive markets, here we assume symmetric information. We do not assume that sellers know more than buyers. There are informed purchasing agents on the buy side who spend considerable resources to gather data on suppliers and their products. They develop technical expertise, force suppliers to share proprietary information, visit plants, reveal specifications, and demand data from competing manufacturers.
Bilateral oligopolies can also occur where there is product differentiation and marketing. The distribution of market power becomes more problematical and may depend on marketing strategies. In consumer products markets an important question is: do manufacturers use a push (sell to retailers) or pull (market to final consumers) marketing strategy? The ability of a manufacturer to create consumer demand through advertising and promotion strengthens its bargaining position with retailers, both to get shelf space and when negotiating net price. The manufacturer has to estimate whether these benefits are worth the extra marketing costs.
Although products and services may be differentiated in the eyes of producers, in some intermediate markets the competing products may be almost undifferentiated (almost perfect substitutes) in the eyes of purchasing agents. Tires and computers are examples. Demand from professional buyers for each product is more elastic than assumed by the producers. Producers misjudge the price elasticity of demand. They offer to sell at a higher price than buyers are willing to pay. Buyers then institute price competition by playing off one supplier against another, negating the market power of the large suppliers. By such means as competitive or sealed bids, or offering large, long-term supply contracts, buyers decide mostly on the basis of price. Final market price is indeterminate, partly dependent on negotiating skills.
Professional buyers and purchasing agents, following the self-interest of their company, are negotiating prices on behalf of the final consumer. This is a major source of price competition in retail markets. If buyers have elastic demand and can negate the supplier's market power, the market price will probably be closer to the theoretical price reached in a perfectly competitive market.
Many producers sell intermediate goods and capital goods to final producers and assemblers. Final producers often sell to large wholesalers, distributors and retailers. Even small retailers often purchase through franchisors, buying offices or big coop distributors like True Value. In all these situations, it is professional buyers who make the buying decision. Purchasing agents and new product committees are well-informed about their suppliers. Because they represent large customers, they have substantial market power, playing off one supplier against another. They buy in large volume, often for their own private label, and are compensated for negotiating low prices. In the extreme, retailers like Walmart force suppliers to offer prices close to the suppliers' marginal cost, the same prices that would prevail in a perfectly-competitive market.
In many bilateral oligopolistic markets, price is the primary consideration in the purchasing decision. Professional buyers are not swayed by marketing or advertising. Brand names are often unimportant or irrelevant in markets for raw materials, commodities, industrial products, intermediate goods, commodity chemicals, products made to buyer’s specifications, generic products, and private label products. Price at or near marginal cost occurs when competing products are close or perfect substitutes in the eyes of the professional buyers. When buyers view alternative sources of inputs as close substitutes, sellers can not charge a premium price based on perceived superior value. In economic jargon, buyers have price elastic demand.
Corporate buyers have leverage if their company is a relatively big part of the market or if producers have large economies of scale. The downside of scale economies in an industrial economy is large fixed costs and low marginal cost compared to price. One implication of large economies of scale is that producers are forced to run plants at a high percent of capacity to make a profit. Industries with large economies of scale also often have industry overcapacity so that not all companies can run their plants at full capacity. As long as price is above marginal cost, some companies would be willing to expand output to increase profit or reduce loss. For example, auto company purchasing agents negotiate with large suppliers from the steel, aluminum, plastics, and tire industries, all of which periodically have excess capacity.
There are a small number of producers in many markets for raw material, semi-processed goods or industrial products because of large economies of scale. Scale economies create the "through-put problem" for suppliers (see the writings of Alfred D. Chandler).
Economies of scale are made possible by large up-front investment in fixed assets. Units of output have low variable cost. But there is low average (unit) cost only if plants are run at high rates of capacity. If producers have high fixed cost relative to variable costs and must operate plants at a high percent of capacity to make an adequate rate of return, or plant closing costs are high, then large buyers might be able to force the contract or negotiated price down close to marginal cost.
Many large manufacturers face large assemblers or retailers as major customers. If products are viewed as homogeneous by buyers, suppliers are chosen primarily on price. Buyers use a number of bidding and contract negotiation procedures to maximize the amount of price competition among potential suppliers.
For some products, like computer hardware and systems, the part of the market where computer companies sell computer systems to large institutions contains aspects of bilateral oligopoly. About 40% of total demand for information technology comes from large companies, about 45% from midsize to small businesses, and only about 15% from individual consumers. Merrill Lynch, like many banks and other large financial companies, spend over $1 billion a year on computers and computer systems. They have tremendous market power - negotiating power - when they decide which suppliers to choose.
Buyers for assemblers and retailers typically face final consumers and competitors in their product markets. So demand in intermediate markets is derived from the buyers' forecasts of final consumer demand. Professional buyers are actually negotiating part of the cost of the final product for the ultimate consumer. They have a big incentive to try for the lowest cost of inputs, which will give their company a competitive advantage in the output market.
Price competition in the final goods or retail market keeps profit margins down.
Unlike other imperfectly competitive markets, here we assume symmetric information. We do not assume that sellers know more than buyers. There are informed purchasing agents on the buy side who spend considerable resources to gather data on suppliers and their products. They develop technical expertise, force suppliers to share proprietary information, visit plants, reveal specifications, and demand data from competing manufacturers.
Bilateral oligopolies can also occur where there is product differentiation and marketing. The distribution of market power becomes more problematical and may depend on marketing strategies. In consumer products markets an important question is: do manufacturers use a push (sell to retailers) or pull (market to final consumers) marketing strategy? The ability of a manufacturer to create consumer demand through advertising and promotion strengthens its bargaining position with retailers, both to get shelf space and when negotiating net price. The manufacturer has to estimate whether these benefits are worth the extra marketing costs.
Although products and services may be differentiated in the eyes of producers, in some intermediate markets the competing products may be almost undifferentiated (almost perfect substitutes) in the eyes of purchasing agents. Tires and computers are examples. Demand from professional buyers for each product is more elastic than assumed by the producers. Producers misjudge the price elasticity of demand. They offer to sell at a higher price than buyers are willing to pay. Buyers then institute price competition by playing off one supplier against another, negating the market power of the large suppliers. By such means as competitive or sealed bids, or offering large, long-term supply contracts, buyers decide mostly on the basis of price. Final market price is indeterminate, partly dependent on negotiating skills.
Professional buyers and purchasing agents, following the self-interest of their company, are negotiating prices on behalf of the final consumer. This is a major source of price competition in retail markets. If buyers have elastic demand and can negate the supplier's market power, the market price will probably be closer to the theoretical price reached in a perfectly competitive market.
MARKET SHARE AND MARKET POWER
It is usually assumed that a large market share translates into market power, the ability of a company to charge prices substantially above marginal cost (and unit cost) and make above-average rates of return. In a bilateral oligopoly market, however, large market shares of suppliers can be countered by large market shares of buyers. If the main reason for a small number of big producers is economies of scale relative to the total size of the market, then market power typically swings over to the buyers' side. This is especially true if there is excess capacity in the industry, a common situation in manufacturing industries with large economies of scale.
Large producers may also not have much market power if every sale is important. This is the usual situation in transportation equipment - Boeing vs. Airbus selling jet aircraft in multi-billion dollar deals, large containerships and oil tankers, and diesel locomotives sold to the three major railroads left in the United States or national railroads in other countries. Other examples in large capital goods markets are electric power-generating equipment or large earth-moving equipment (Caterpillar vs. Komatsu and John Deere). Another possibility is large construction companies and their suppliers bidding on big construction projects.
This implies that the heart of a company's strategy in a bilateral oligopoly is to use its purchasing power and knowledge of the market to hold down the costs of inputs purchased from outside suppliers. This strategy is crucial if the company is to be price-competitive in its output market. In an output market of few suppliers, the company must be price competitive if it pursues a market share strategy. It will be argued later that in such a market, increasingly market share in the short run is a tactic to increase profitability in the long run.
When there are a small number of well-informed buyers, they can constantly and effectively monitor the market. They will be especially sensitive to any attempts by suppliers to cooperate since the buyers' companies are the immediate victims of supplier collusion. Buyers may find it hard to pass on high input costs to their oligopolistic customers. Buyers and purchasing agents can initiate "cheating", that is, price competition among suppliers. This is one reason for the small amount of overt collusion in U.S. industry.
Even in a duopolistic retail market like that of cola, Coke and Pepsi compete for market share. Supermarkets can often negotiate lower prices with one company in exchange for more shelf space and greater volume purchases. This puts pressure on the other company to match the lower price.
It is usually assumed that a large market share translates into market power, the ability of a company to charge prices substantially above marginal cost (and unit cost) and make above-average rates of return. In a bilateral oligopoly market, however, large market shares of suppliers can be countered by large market shares of buyers. If the main reason for a small number of big producers is economies of scale relative to the total size of the market, then market power typically swings over to the buyers' side. This is especially true if there is excess capacity in the industry, a common situation in manufacturing industries with large economies of scale.
Large producers may also not have much market power if every sale is important. This is the usual situation in transportation equipment - Boeing vs. Airbus selling jet aircraft in multi-billion dollar deals, large containerships and oil tankers, and diesel locomotives sold to the three major railroads left in the United States or national railroads in other countries. Other examples in large capital goods markets are electric power-generating equipment or large earth-moving equipment (Caterpillar vs. Komatsu and John Deere). Another possibility is large construction companies and their suppliers bidding on big construction projects.
This implies that the heart of a company's strategy in a bilateral oligopoly is to use its purchasing power and knowledge of the market to hold down the costs of inputs purchased from outside suppliers. This strategy is crucial if the company is to be price-competitive in its output market. In an output market of few suppliers, the company must be price competitive if it pursues a market share strategy. It will be argued later that in such a market, increasingly market share in the short run is a tactic to increase profitability in the long run.
When there are a small number of well-informed buyers, they can constantly and effectively monitor the market. They will be especially sensitive to any attempts by suppliers to cooperate since the buyers' companies are the immediate victims of supplier collusion. Buyers may find it hard to pass on high input costs to their oligopolistic customers. Buyers and purchasing agents can initiate "cheating", that is, price competition among suppliers. This is one reason for the small amount of overt collusion in U.S. industry.
Even in a duopolistic retail market like that of cola, Coke and Pepsi compete for market share. Supermarkets can often negotiate lower prices with one company in exchange for more shelf space and greater volume purchases. This puts pressure on the other company to match the lower price.
DUAL MARKET: SELLING INTO RETAIL AND BILATERAL OLIGOPOLISTIC INSTITUTIONAL MARKET
Corporate buyers are in a strong position if the same product is sold in both retail and industrial markets. Institutional buyers initiate a form of price discrimination, demanding lower prices than the wholesale prices to the retail market. Price discrimination here works in favor of buyers if sellers are forced by competition or excess capacity to offer lower prices to large, well-informed corporate customers in the original equipment market.
Only part of the total market, the industrial part, has to be price-sensitive - textiles sold to industrial users, tires to car manufacturers, cola bought by fast food chains, personal computers bought by corporate buyers.
Corporate buyers are in a strong position if the same product is sold in both retail and industrial markets. Institutional buyers initiate a form of price discrimination, demanding lower prices than the wholesale prices to the retail market. Price discrimination here works in favor of buyers if sellers are forced by competition or excess capacity to offer lower prices to large, well-informed corporate customers in the original equipment market.
Only part of the total market, the industrial part, has to be price-sensitive - textiles sold to industrial users, tires to car manufacturers, cola bought by fast food chains, personal computers bought by corporate buyers.
BILATERAL OLIGOPOLY AND VERTICAL INTEGRATION
Being a buyer in a bilateral oligopoly is a good reason why an assembler or retailer should not integrate backwards (backwards vertical integration). In the short run, the market is characterized by fierce price competition. In the long run, a company does not want to get locked into one development path based on one type of technology. The examples of what happened to IBM (fell behind Intel in microprocessors), U.S. Steel (did not adopt minimill technology or electric arc technology, partly because of its massive investment in older technology) and General Motors (lack of innovation, inefficient internal coordination), all depending almost entirely on in-house research and development, caution against vertical integration. General Motors in particular would be much more price-competitive if it could buy components from outside suppliers at a lower cost than those produced by its own parts divisions.
Any company that can credibly threaten to produce its own inputs strengthens its bargaining position.
Being a buyer in a bilateral oligopoly is a good reason why an assembler or retailer should not integrate backwards (backwards vertical integration). In the short run, the market is characterized by fierce price competition. In the long run, a company does not want to get locked into one development path based on one type of technology. The examples of what happened to IBM (fell behind Intel in microprocessors), U.S. Steel (did not adopt minimill technology or electric arc technology, partly because of its massive investment in older technology) and General Motors (lack of innovation, inefficient internal coordination), all depending almost entirely on in-house research and development, caution against vertical integration. General Motors in particular would be much more price-competitive if it could buy components from outside suppliers at a lower cost than those produced by its own parts divisions.
Any company that can credibly threaten to produce its own inputs strengthens its bargaining position.
BILATERAL OLIGOPOLY AND OTHER STRATEGIES
There is a range of possible non-price strategies for companies in a bilateral oligopoly. The relationships with suppliers are crucial to a retailer's or assembler's success. Types of relationships with suppliers, besides arms-length competitive, include captive (Sears), exploitative (cola bottlers and sometimes car dealers), cooperative (buying coops like hardware stores or agriculture co-ops), franchise, or keiretsu (long-term strategic alliance).
Long-term cooperation with suppliers is an alternative to vertical integration or arms-length negotiating. The examples of keiretsu in Japan indicate that strategic alliances formalize the dominant market power of final assemblers over suppliers. The classic example is Toyota, which forces price reduction on suppliers when demand for Toyotas is weak. This is probably why independent auto parts suppliers prefer not to become a “captive” supplier, even if guaranteed sole supplier status.
Additional advantages to buyers are that transaction costs, at least in the long run, can be reduced through the sharing of internal proprietary information and joint decision-making. Buyers obtain most of the advantages of vertical integration without the costs of capital investment or direct operational management. This also lowers financial risk because the final assembler does not invest in the parts suppliers.
Another strategy, not seldom practiced, is for a large supplier to develop its own distribution network or buy a major company on the demand side of a bilateral oligopoly market. Sherwin Williams, a paint manufacturer, developed its own retail outlet chain, trading this off against not being able to sell to large home improvement chains like Home Depot. Apple has opened its own stores although, imitating the old Singer sewing machine stores, Apple stores emphasize demonstating the product and providing service support. Pfizer bought one of the largest mail order drug distributors. Generally, however, the set of specialized knowledge that leads to success as a manufacturer is not transferable to success as a retailer or wholesaler.
There is a range of possible non-price strategies for companies in a bilateral oligopoly. The relationships with suppliers are crucial to a retailer's or assembler's success. Types of relationships with suppliers, besides arms-length competitive, include captive (Sears), exploitative (cola bottlers and sometimes car dealers), cooperative (buying coops like hardware stores or agriculture co-ops), franchise, or keiretsu (long-term strategic alliance).
Long-term cooperation with suppliers is an alternative to vertical integration or arms-length negotiating. The examples of keiretsu in Japan indicate that strategic alliances formalize the dominant market power of final assemblers over suppliers. The classic example is Toyota, which forces price reduction on suppliers when demand for Toyotas is weak. This is probably why independent auto parts suppliers prefer not to become a “captive” supplier, even if guaranteed sole supplier status.
Additional advantages to buyers are that transaction costs, at least in the long run, can be reduced through the sharing of internal proprietary information and joint decision-making. Buyers obtain most of the advantages of vertical integration without the costs of capital investment or direct operational management. This also lowers financial risk because the final assembler does not invest in the parts suppliers.
Another strategy, not seldom practiced, is for a large supplier to develop its own distribution network or buy a major company on the demand side of a bilateral oligopoly market. Sherwin Williams, a paint manufacturer, developed its own retail outlet chain, trading this off against not being able to sell to large home improvement chains like Home Depot. Apple has opened its own stores although, imitating the old Singer sewing machine stores, Apple stores emphasize demonstating the product and providing service support. Pfizer bought one of the largest mail order drug distributors. Generally, however, the set of specialized knowledge that leads to success as a manufacturer is not transferable to success as a retailer or wholesaler.
EXAMPLES OF BILATERAL OLIGOPOLIES
1. Big-ticket item industries
2. Big suppliers vs. "category-killer" retailers
3. Intermediate products
Intel (and Microsoft) vs. Dell and HP. An example where the market power resides with the suppliers because of network externalities and first mover advantages. By dominating the input side of personal computers, Intel and Microsoft have made the output side close to a commodity business (perfectly-competitive) for the personal computer companies. But these two dominant companies were slow getting into other part of the computer business, slow in developing specialized chips and software for servers, graphic chips, gaming, cloud computing, mobile phones, and other applications.
Steel, aluminum, and tire companies vs. auto companies
4. Other supply chain relationships
5. Split markets - big corporate customers and consumer retail market (price discrimination)
1. Big-ticket item industries
Aircraft engines (GE, Pratt and Whitney and Rolls-Royce) vs. aircraft (Boeing and Airbus)
Boeing and Airbus vs. airlines
Locomotives vs. railroads
Integrated telecom systems vs. large telecom companies
Oil tanker builders vs. oil companies
2. Big suppliers vs. "category-killer" retailers
Book publishers vs. Amazon and Barnes and Noble
Toy producers like Mattel and Hasbro vs. Walmart
Computer companies vs. Best Buy and large corporate customers
Home textile companies vs. Bed, Bath and Beyond
Black and Decker vs. Home Depot
Proctor and Gamble vs. Walmart
Every large consumer goods manufacturer vs. Amazon
Specialized consumer goods manufacturers vs. specialized online retailers
3. Intermediate products
Intel (and Microsoft) vs. Dell and HP. An example where the market power resides with the suppliers because of network externalities and first mover advantages. By dominating the input side of personal computers, Intel and Microsoft have made the output side close to a commodity business (perfectly-competitive) for the personal computer companies. But these two dominant companies were slow getting into other part of the computer business, slow in developing specialized chips and software for servers, graphic chips, gaming, cloud computing, mobile phones, and other applications.
Steel, aluminum, and tire companies vs. auto companies
4. Other supply chain relationships
Home appliances vs. Home Depot and Lowe's.
HMOs. vs. hospitals. Hospitals are capturing market power vs. HMOs through mergers.
Prescription drugs vs. CVS and prescription management companies like Express Scripts.
Cable channels vs. cable networks. Here some cable networks have exploited their access to customers to force cable channels to sell part ownership to the cable networks.
5. Split markets - big corporate customers and consumer retail market (price discrimination)
Tires, computers, food (institutional distributors), auto parts.
Autos sold to car rental firms and big fleet buyers.
INDUSTRY STRUCTURE AND INTERNAL CORPORATE ORGANIZATION
This brings up the issue of the relationship between industry structure and internal organization. Companies that recognize they are in a bilateral oligopoly may be less likely to have a fully-developed divisional structure. The reasons could be a small marketing function on the supply side since advertising and promotion have limited effect on professional buyers, or a small product development function on the buy side. The result could be a simpler management structure. Supplier firms will tend to be production-oriented, not market-oriented. Many of the functions of a self-contained division are not necessary or are performed elsewhere (by customers, by suppliers, or by specialized capital goods companies) or jointly with customers.
An important determinant of the internal structure of a firm will be the transaction costs to the firm as a buyer of inputs. If transaction costs are low, possibly because of accumulated knowledge of the market and its suppliers, the firm will have low purchasing costs. Internal coordination costs between purchasing and production, and related inventory costs, may be low if the purchaser can impose “just-in-time” delivery schedules on suppliers. Also, net transaction costs may be low if the cost of accumulating knowledge about suppliers translates into lower prices for a large volume of inputs.
Capital goods producers and other input suppliers usually have a large research and development (R&D) function. Long run competitive position depends on providing new and improved inputs that benefit corporate customers - lower costs, increase productivity, better quality, making possible the design and production of new final products. Being able to provide superior inputs is necessary for short run bargaining power and long run survivial.
This brings up the issue of the relationship between industry structure and internal organization. Companies that recognize they are in a bilateral oligopoly may be less likely to have a fully-developed divisional structure. The reasons could be a small marketing function on the supply side since advertising and promotion have limited effect on professional buyers, or a small product development function on the buy side. The result could be a simpler management structure. Supplier firms will tend to be production-oriented, not market-oriented. Many of the functions of a self-contained division are not necessary or are performed elsewhere (by customers, by suppliers, or by specialized capital goods companies) or jointly with customers.
An important determinant of the internal structure of a firm will be the transaction costs to the firm as a buyer of inputs. If transaction costs are low, possibly because of accumulated knowledge of the market and its suppliers, the firm will have low purchasing costs. Internal coordination costs between purchasing and production, and related inventory costs, may be low if the purchaser can impose “just-in-time” delivery schedules on suppliers. Also, net transaction costs may be low if the cost of accumulating knowledge about suppliers translates into lower prices for a large volume of inputs.
Capital goods producers and other input suppliers usually have a large research and development (R&D) function. Long run competitive position depends on providing new and improved inputs that benefit corporate customers - lower costs, increase productivity, better quality, making possible the design and production of new final products. Being able to provide superior inputs is necessary for short run bargaining power and long run survivial.
LINKED MARKETS AND INDUSTRY STRUCTURES
Economics textbooks implicitly assume that a firm buys inputs (raw materials, machinery and labor) and then sells the output to the final consumer. The reality is more complicated; an industry is a series of linked markets. Unless a firm is vertically integrated, it participates in two linked markets, one as a buyer and the next as a seller. The two markets may have different structures. For example, the market for raw materials like agricultural products is often approximately perfectly competitive. On the other end, retail markets are so price-competitive that price is often close to marginal cost. But between these two markets the intermediate markets are often bilateral oligopolies. A firm may face two different competitive environments.
The implication here is that a company has more market power as a buyer of inputs than as a seller of outputs. Both situations tend to keep the price down - lower input costs and lower profit margins on output. This situation is obviously good for consumers.
Economics textbooks implicitly assume that a firm buys inputs (raw materials, machinery and labor) and then sells the output to the final consumer. The reality is more complicated; an industry is a series of linked markets. Unless a firm is vertically integrated, it participates in two linked markets, one as a buyer and the next as a seller. The two markets may have different structures. For example, the market for raw materials like agricultural products is often approximately perfectly competitive. On the other end, retail markets are so price-competitive that price is often close to marginal cost. But between these two markets the intermediate markets are often bilateral oligopolies. A firm may face two different competitive environments.
The implication here is that a company has more market power as a buyer of inputs than as a seller of outputs. Both situations tend to keep the price down - lower input costs and lower profit margins on output. This situation is obviously good for consumers.
INTERNAL STABILITY OF AN ECONOMIC SYSTEM WITH BILATERAL OLIGOPOLIES
The overall picture is that of a short-run system of constantly adjusting, negotiated prices. There may not be a stable, long-run equilibrium price (or fluctuations around some mean-value price.) because of lack of stability in negotiating skills or changing relationships between suppliers and purchasing agents. Even if there are perfectly competitive prices in some raw materials and input markets, there is a bilateral oligopoly pricing mechanism in many intermediate markets, markets before retail sales to final consumers. Then intensely competitive retail markets, as seen by the rise of discounters (45% of general merchandise sales), category killers, mail order drugs and Internet marketing, probably puts more price pressure on suppliers. The result is that there may be very little inefficiency in the economy due to the market power of large corporations if most intermediary markets are bilateral oligopolies.
The overall picture is that of a short-run system of constantly adjusting, negotiated prices. There may not be a stable, long-run equilibrium price (or fluctuations around some mean-value price.) because of lack of stability in negotiating skills or changing relationships between suppliers and purchasing agents. Even if there are perfectly competitive prices in some raw materials and input markets, there is a bilateral oligopoly pricing mechanism in many intermediate markets, markets before retail sales to final consumers. Then intensely competitive retail markets, as seen by the rise of discounters (45% of general merchandise sales), category killers, mail order drugs and Internet marketing, probably puts more price pressure on suppliers. The result is that there may be very little inefficiency in the economy due to the market power of large corporations if most intermediary markets are bilateral oligopolies.
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For Baldwin Locomotive and other examples of bilateral oligopoly, see Examples of Bilateral Oligopoly
For a modern example, see Markets and Large Companies: A Case Study of Parker Hannifin
For a list of all posts, see Guide to Posts.
For a list of all posts, see Guide to Posts.
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